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Traditional Cash Flow vs UCA

I have a question regarding the use of debt service capacity ratios and cash flow.

UCA cash flow is helpful for a lender to understand how management has chosen to use cash. When a business has negative cash after operations, it usually is from fluctuations in the working assets of the business (usually A/R or inventory). At what point do you say "this company is just growing" or "this company has cash flow issues"? I guess where I have problems is when I see sales growing, which would mean that receivables are probably growing and/or inventory growing, when is negative cash after operations really a sign of cash flow problems?

What are the key items to look at? Do you look to see if the turnover ratios are increasing beyond industry averages? What if the income statement shows a profit and that margins look in line with previous years? Would it not be feasile to say that if managment choose not to grow their business, they wouldnt have the large uses of cash in A/R and inventory? What company doesnt want there business to grow?

Regarding the traditional cash flow method to calculate DSC, do you ever use it on a business to determine if they can "operate" at a level to service the debt? I understand that net income is not cash, but it at least shows that they "operated" at a level to earn the cash available to service the debt? Does that make sense?

Just some thoughts I have when I look at UCA cash flow and traditional cash flow. All in an effort to understand it all better.

”…..UCA cash flow is helpful for a lender to understand how management has chosen to use cash. ….” I don’t like the assumption that it was management’s decision. When I am looking at a historical UCA cash flow, I am looking at what happened whether or not management chose it.

”….When a business has negative cash after operations, it usually is from fluctuations in the working assets of the business (usually A/R or inventory). At what point do you say "this company is just growing" or "this company has cash flow issues"?” Assuming that the negative NCAO is not due to a change in the cost structure or that the company is not being squeezed by vendors {usually with good reason}. Then I would have to look at the relative growth of the A/R and Inventory to revenue. You mentioned turnover and that would be the first place that I would look. I would probably not rely on industry averages too much, but would like to understand why the turnover is slowing down. By the way, A/R and inventory turnover slowdown, which is enough to get you to negative cash flow when you were positive before sounds like a textbook definition of “cash flow problem”.

”….. What if the income statement shows a profit and that margins look in line with previous years? Would it not be feasile to say that if managment choose not to grow their business, they wouldnt have the large uses of cash in A/R and inventory? What company doesnt want there business to grow?. ….” Everything is relative, that is why we look at ratios. If it was positive and it is now negative….. something happened. Best approach would be to get the ratios and ask the company. An additional step would be to get A/R aging report and inventory listings to see if you can spot a problem {this would be easier to do if you have older ones in file}. The next step would be visiting the business and looking at their operations.

”….. Regarding the traditional cash flow method to calculate DSC, do you ever use it on a business to determine if they can "operate" at a level to service the debt? I understand that net income is not cash, but it at least shows that they "operated" at a level to earn the cash available to service the debt? Does that make sense?. ….” It makes a little sense…. If you mean: Do you run breakeven scenarios assuming a particular level of sales? Then the answer is yes. I run a sales breakeven, a gross margin breakeven if I think is worth it, and an interest sensitivity if there is a lot of variable debt or our loan is variable.